Autumnal doldrums for the CMBS market

Commercial mortgage rates have shown little change since Labor Day, according to the Barron's/John B. Levy & Co. National Mortgage Survey of more than 30 industry participants. Along with interest-rate stability has come a noticeable improvement in the tone of the market, especially on the commercial mortgage-backed securities side. Part of the good cheer in the market is based upon the fact that the upcoming CMBS securitization volume appears to be steady and not nearly as overwhelming as some analysts had predicted just weeks ago. Additionally, offerings of corporate debt and asset-backed securities have moderated as well.

New loan originations have clearly declined for both conduit originators and life insurance companies. Several life insurance company executives noted that the upsurge of loan applications, which normally occurs after Labor Day, has failed to materialize. A number of conduit executives reported a material decline in their pipelines of pending deals, which implies that the future volume of securities will be more modest.

CMBS spreads have tightened dramatically over the past two weeks. According to Morgan Stanley's Louis Colosimo, "Despite close to $1 billion in secondary CMBS trades in the last two weeks, spreads tightened by approximately 20 basis points at the triple-A level." Offering a contrary view, one money manager noted that spreads have moved too far, too fast and would widen.

Hoping to take advantage of the market's more positive tone are three securitizations: a $490 million offering from Teachers Insurance & Annuity Association, a $907 million transaction from Lehman Brothers, and a $981 million transaction from DLJ and GE Capital. The Lehman Brothers transaction is the one drawing the most attention. This securitization is considered a "fusion deal" because it includes two large loans as well as more than 130 smaller, conduit-type loans. The two large loans are a $210 million loan on the SunAmerica Center and an unrelated $160 million loan on the Century City Shopping Center, both in the Los Angeles area.

Industry analysts note that Lehman has cleverly managed to sell the bottom tranches of these large loans to Teachers Insurance & Annuity Association while putting senior tranches into the securitization. The $457 million Class A-2, rated triple-A, is expected to draw a spread in the range of 1.31% to 1.36%.

In spite of encouraging signs in the market, there are some warning signs. Earlier in the fall, Moody's downgraded a Nomura Securities CMBS offering known as MD-7. This $500 million securitization, which closed in April 1997, includes a $165 million loan on a number of Fairfield Inns, which are owned and managed by affiliates of Host Marriott Corp. Expenses at the properties were up, reportedly due to the tight labor market, which caused Moody's to downgrade at least two tranches by one notch, with thoughts that further downgrades might be forthcoming.

Although hotels are known to be problematic, the pristine multifamily area is not free of difficulties. "Overall, multifamily markets are good, but Atlanta, Las Vegas and Phoenix, to name a few, are showing signs of softening, replete with rent concessions," says Charlie Olsen, vice president and chief credit officer at Freddie Mac.

While the CMBS market is primarily composed of loans on U.S. properties, attractive spreads are drawing interest from foreigners, especially the Japanese. Several money managers said that they had been contacted by Japanese financial institutions that were interested in having them manage several hundred million dollars to be invested in triple-A-rated CMBS. BlackRock Financial, a unit of PNC Corp., reportedly is trying to raise Japanese funds for CMBS investment through a joint venture with Nomura.

On the Y2K front, the market is a little less jittery. Until recently, few institutions wanted to commit to transactions after November 1. Now the operative date appears to be December 1. In either case, the fear factor about a financial meltdown seems to be gradually eroding.